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Daqo New Energy: A cheap Chinese stock in a rapidly expanding market.

Opdateret: 24. feb.

Like many other Chinese stocks, Daqo New Energy is currently trading at a low price below its book value. Furthermore, they are operating in a growing sector, which should result in favorable conditions for a significant period of time. If you are considering investing in Chinese stocks, you will need to be prepared for volatility. However, is an investment in Daqo New Energy too good to pass up?

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

This analysis will be a bit different from what you are used to read in my blog. Daqo New Energy did their IPO in 2021, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to get different numbers from various companies.

Before I start with the analysis, I should mention that at the time of writing this analysis, I do own shares in Daqo New Energy, which is 4,15 % of my portfolio. I'm also an investor in another company in the sector ,as I own shares in Canadian Solar, which is 2,52 % of my portfolio. If you would like to see or copy my portfolio, you can read how to access it here. If you want to buy shares in Daqo New Energy and/or Canadian Solar, you can do so at eToro.

Daqo New Energy is a Chinese company that was founded in 2008 but did not go public until 2021. It is a prominent manufacturer of high-purity polysilicon for the global solar photovoltaic industry. It is one of the world's lowest-cost producers of high-purity polysilicon. All of Daqo New Energy's manufacturing operations are based in China. They have operations in Xinjiang and are now expanding to Inner Mongolia, an autonomous region in China. In 2022, they produced 133.812 MT of polysilicon, while they expect production to be between 190.000 and 195.000 MT in 2023. Daqo New Energy is the third-largest polysilicon producer in the world, following Tongwei and GCL Technology, both of which are Chinese as well. Chinese producers benefit from subsidized capital expenditures, low raw material and labor costs, as well as inexpensive electricity costs. This has allowed Chinese producers to establish a competitive advantage over producers from other countries. While there is still competition inside China, I would say that Daqo New Energy has a toll moat that protects it from international competition.

Their CEO is Xiang Xu. He joined Daqo New Energy as a director in 2007 and has held various positions until he became the CEO in August 2023. He holds an EMBA (Executive MBA) degree from Nanjing University. He has significant expertise in the solar industry and corporate management. He is also the son of the founder, Chairman of the Board, and the largest individual shareholder in Daqo New Energy. I haven't been able to find much information about Xiang Xu, but he has worked in the solar industry for most of his career. Considering that he is the largest shareholder in the company, it can be assumed that he has a vested interest in the success of Daqo New Energy. Thus, I will give Xiang Xu the benefit of the doubt, despite the lack of information.

I believe that Daqo New Energy has a toll moat. While I don't have much information about the management, I will give it the benefit of the doubt because of their vast experience in the sector and large share ownership. Later, I will use a discounted cash flow model to calculate a price for Daqo New Energy. However, before doing so, let's take a look at some key financial metrics.

Below, we present some key financial metrics for Daqo New Energy. The revenue growth has been extraordinary from year to year, as they have more than doubled their revenue each year since 2020. Not only have they experienced tremendous growth in revenue, but margins have also significantly improved. The gross profit margin they reached in 2021, at 65,4 % is impressive. However, they managed to further increase the gross profit margin to an impressive 74,0% in 2022. The operating margin, EBITDA margin, and EBIT margin have all increased year over year. This indicates that the company is becoming more profitable. EPS has also tremendously increased year over year. I cannot find anything negative to write about these numbers, and I am astounded by the impressive performance that Daqo New Energy has consistently delivered over the years.

Despite the astounding results, no investment comes without risk, and there are risks associated with investing in Daqo New Energy as well. One risk is the price of polysilicon. Daqo New Energy is highly sensitive to the price of polysilicon. Although the price of polysilicon reached a record high in 2022, it has since dropped and is currently trading at the same price as it did in 2020. Furthermore, it is not only Daqo New Energy that is increasing its production of polysilicon; some of their competitors are also doing the same. As more polysilicon enters the market, it could further drive down the price.. Another risk is customer concentration. Daqo New Energy has a high customer concentration, as three of their customers accounted for 61,4 % of their revenue in 2021. The reliance on the three customers has decreased, as they contributed to more than 80% of the revenue in 2019. However, customer concentration still poses a risk. If Daqo New Energy were to lose one of their three major customers, it would have a significant impact on their business. Finally, we cannot avoid the risk associated with China. There are risks associated with investing in China. At the time of writing this analysis, there are geopolitical tensions between the United States and China. If these tensions escalate, it will have a negative impact on Chinese stocks. Hopefully, it won't spiral out of control. However, even if it doesn't, it will still contribute to the negative sentiment towards China. The Holding Foreign Companies Accountable Act has not been resolved yet. Although management expressed optimism during the Q4 2022 earnings call, it remains a risk until it is resolved. Finally, Daqo New Energy has operations in Xinjiang, a region that has come under scrutiny because of forced labor. And while Daqo New Energy has opened its factory for journalists, and they wasn't mentioned in the list of companies using forced labor in Homeland Security's report to Congress on forced labor in China, it is something to be aware of. If Daqo New Energy is indeed using forced labor, it obviously becomes "uninvestable."

There are also reasons to invest in Daqo New Energy moving forward. The solar sector will grow. According to Global News Wire, the polysilicon market is expected to grow at a compound annual growth rate (CAGR) of 7,3 % until 2027. However, Contrive Datum Insights is more optimistic and predicts that the global polysilicon market will reach $27,07billion by 2030, indicating a CAGR of 13,2 % until 2030. While there may be some variations in the annual growth rate, we can expect a global shift towards green energy in the coming decades, and Daqo New Energy is poised to benefit from this transition. In the Q4 2022 earnings call, management mentioned that the transition to green energy is still in its early stages and that the potential is likely to exceed expectations. Daqo New Energy will remain profitable even with lower polysilicon prices. The average polysilicon production cost for Daqo New Energy was $7,78/kg in Q4 2022, while the average polysilicon selling price was $37,41/kg in the same quarter. Hence, Daqo New Energy still has plenty of room for the price to drop and still remain profitable. Management has also mentioned that they outperform most of their peers in terms of unit profitability, cost structure, and product quality. Management also mentioned that they will continue to generate a significant cash flow as they are the lowest-cost producer in the world with some of the highest quality. The stock is inexpensive. As I write this, the stock of Daqo New Energy is trading below the book value per share of $64,65. Furthermore, management has introduced a $700 million share buyback program, which is significant considering the current market cap of $2,9 billion! Hence, when executed, the share buyback will significantly decrease the number of shares.

I have now investigated the financials, risks, and potential of Daqo New Energy. I will now examine the price by utilizing a discounted cash flow model. To do so, I will need some numbers that you can see below. The numbers are the 2022 figures, which I found an Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to go with 3%, which is a figure in the middle, due to the current market conditions. The chosen discount rate of 12% is because it falls within the typical range of 9-12%. I decided to go with the highest one because of the absence of a moat. Remember that all the numbers used in these calculations are in millions.

I also need to determine how much EBIT, Depreciation & Amortization, and Net Working Capital will change over the next couple of years. According to Finbox, EBIT is projected to decrease by an average of 26% over the next five years. I'm not sure that I agree, but I have made two calculations. One with EBIT decreases by 20% each year for the next 5 years, and in the other scenario, it remains unchanged. Hence, I have made no calculations with EBIT growing, despite it having grown an average of 173% per year over the last five years. I decided to keep Depreciation & Amortization flat as well, despite it growing an average of 40% per year in the last five years. Finally, I have made two calculations using Net Working Capital (NWC). One scenario is where it remains flat, and the other is where it decreases by 10% per year. Finbox expects Net Working Capital to decrease by 14% per year over the next five years. The results were as follows: If EBIT decreases by 20% per year and NWC remains flat, the intrinsic value would be $110. If EBIT decreased by 20% per year and NWC decreased by 10% per year, the intrinsic value would be $125. If EBIT and NWC remain unchanged, the intrinsic value would be $219. If EBIT remains unchanged and NWC decreases by 10% per year, the intrinsic value would be $234. Hence, in my most conservative calculation, the intrinsic value of Daqo New Energy is $110.

Having investigated Daqo New Energy, I am impressed with the numbers they have managed to deliver. While there are some uncertainties regarding management, I still believe that the CEO's experience is sufficient for me to feel confident about investing in the company. Margins will likely decrease if the price of polysilicon decreases, but I believe that Daqo New Energy will continue to remain highly profitable. The risk associated with China can be difficult to accept, but I am comfortable with it because I have investments in other Chinese companies. Daqo New Energy not being mentioned in the Homeland Security report is encouraging, as it suggests that they have undergone a thorough investigation. However, if at some point evidence demonstrates their involvement in forced labor, the company will undoubtedly become "uninvestable" for me, as well as for others. However, until such evidence arises, I see no reason why I should not invest in a highly profitable company with a high margin, operating in a growing market. I believe that Daqo New Energy is a buy below its book value of $64,65, and even more so at $55, as it would trade at a 50% discount to my very conservative calculations.

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I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

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